Earnings Preview: Discover’s Struggles Expected To Continue

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DFS: Discover Financial Services logo
DFS
Discover Financial Services

Discover Financial Services (NYSE: DFS) is set to report earnings for the third quarter of the fiscal year 2016 on Tuesday, October 25th. In the second quarter, the company reported a 10.5% year-over-year increase in Earnings Per Share (EPS) on the back of a 2% growth in revenue. The company’s biggest income stream is the interest income it generates on the credit card loans it issues. Since the company issues its own credit cards, it also makes money on transaction fees, assessment fees and other services it offers customers of those cards.

Due to the combined impact of stricter regulation of credit card companies and weak growth in consumer demand in the U.S., the company’s growth in realized income from credit card related income streams has been slow in recent years. Even though the company has grown the number of transactions on its network in the 2011-2015 period from 1.72 billion a year to 2.03 billion, the year-on-year rate of increase has been slowing. It has fallen from 7.3% in 2011 to just 0.6% in 2015. In the previous quarter, the same trend continued as the  revenue realized from Transaction and Execution Fees on credit cards declined by 10% year over year. In the same quarter, while the company increased its interest income from credit card loans, the increase came at the expense of higher provision for loan losses, with the former growing at 7% year over year compared to the 34.6% year over year increase in the latter period.

Overall, the company saw its pre-tax income decline in the previous quarter, and the increase in EPS was largely attributable to the increased share buyback activity from the company. This trend is consistent with the company’s financial management over the five years, in which share buyback activity has been the biggest driver in EPS growth. We expect the same trends to continue in the third quarter as no significant trends directly or indirectly impacting the company have changed. Discover’s challenges remain the same.  It needs to:  1) win back consumer trust following the run ins with regulators in recent years; 2) make its credit cards more widely accepted; and, 3) it needs to keep pace with the rapidly evolving technologies in payment technologies.

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Notes:

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2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Discover
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